14 February 2011

Do Nations Compete for Jobs and Industry?

The image above comes from The Economist and shows the share of profits in the mobile phone industry, with the growing bright blue wedge representing Apple taking a big bite out of Nokia's profits. The Economist writes:

UNTIL 2007 Europe appeared to have beaten Silicon Valley in mobile technology for good. Nokia, based in Finland, was the world's largest handset-maker—and raked in much of the profits. But everything changed when Apple introduced the iPhone in 2007, the first smartphone that deserved the name.

Obviously there are relative winners and losers in the marketplace, but apparently many economists don't think that countries are in competition for jobs or industry. Writing in the NY Times yesterday, Gerg Makiw dismisses the notion of countries in competition with one another, as suggested by President Obama in the State of the Union:

Achieving economic prosperity is not like winning a game, and guiding an economy is not like managing a sports team.

To see why, let’s start with a basic economic transaction. You have a driveway covered in snow and would be willing to pay $40 to have it shoveled. The boy next door can do it in two hours, or he can spend that time playing on his Xbox, an activity he values at $20. The solution is obvious: You offer him $30 to shovel your drive, and he happily agrees.

The key here is that everyone gains from trade. By buying something for $30 that you value at $40, you get $10 of what economists call “consumer surplus.” Similarly, your young neighbor gets $10 of “producer surplus,” because he earns $30 of income by incurring only $20 of cost. Unlike a sports contest, which by necessity has a winner and a loser, a voluntary economic transaction between consenting consumers and producers typically benefits both parties.

This example is not as special as it might seem. The gains from trade would be much the same if your neighbor were manufacturing a good — knitting you a scarf, for example — rather than performing a service. And it would be much the same if, instead of living next door, he was several thousand miles away, say, in Shanghai.

Listening to the president, you might think that competition from China and other rapidly growing nations was one of the larger threats facing the United States. But the essence of economic exchange belies that description. Other nations are best viewed not as our competitors but as our trading partners. Partners are to be welcomed, not feared. As a general matter, their prosperity does not come at our expense.

Rob Atkinson of ITIF has a great post up which critiques such conventional wisdom among economists that nation's are not in competition for jobs and industry. Here is a lengthy excerpt from Rob's post:

When ITIF released our report Effective Corporate Tax Reform for the Global, Innovation Economy, I briefed a group of prominent tax economists on the report. The group included leading tax economists for Congress, Treasury, OMB and other government agencies. The report laid out 6 key principles to guide corporate tax reform efforts. When I got to the principle number 4 – “In a globally competitive economy nations need competitive corporate tax regimes,” – several hands shot up. One economist reflected the group’s consensus when he said “the corporate tax code doesn’t have to reflect this because while Boeing may compete with Airbus, for example, the United States is not in competition with Europe. At this point most heads were nodding in agreement. I should reiterate that these were not academic economists, or junior GS 8’s. These were senior USG economists charged with advising policy makers on tax policy.

When I share this story with colleagues, they look at me with jaws agape, in disbelief. I actually think many don’t even believe me. For such a view is so patently out of touch with the reality of the 21st century global economy that most people just don’t believe that top government advisors actually believe this. But they really do. Just look at a recently op ed by Paul Krugman where he argued that countries don’t compete with one another, only companies, and therefore the entire enterprise of trying to make the U.S. more competitive in international markets is a fool’s errand.

And when the top advisors to USG fundamentally believe that we are not in competition with other nations, they are not likely to push for policies that would make us more competitive. We see this is the current craze over corporate tax reform. President Obama, presumably on the advice of these “we don’t really compete” economists reflected this view when he proposed in his State of the Union address to “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit.” Sound good. Is actually not. This kind of corporate tax reform is exactly what the “we don’t really compete” economists want: a corporate tax code that taxes every industry the same because the government shouldn’t be picking winners.

This brings us back to the states. State tax codes pick winners all the time. By this I mean states try to lower taxes on companies that produce products and services, like manufacturing and software, which are “traded” outside the state. They know that lower taxes on barber shops and dry cleaners don’t matter. The barber shops and restaurants wont’ expand if their taxes are lower. But higher taxes on mobile establishments like a car factory or software firm can mean that that car factory or software firm will move to another state. It’s also why from 1970 to 2008, corporate taxes as a share of overall state tax revenues fell from 8.3 percent to 6.2 percent. States realize that a competitive corporate tax rate, particularly on “traded firms” are essential.

In Washington, corporate tax “reform” would actually make U.S. competitiveness worse for three key reasons. First, as long as corporate tax reform has to be revenue neutral, it means that U.S. companies overall will still pay high taxes, unlike our international competitors (oops, I mean “other nations”), most of which have lowered effective corporate tax rates over the last two decades. Second, corporate tax reform risks cutting rather than expanding, tax incentives which are critical to growth and innovation, such as the R&D tax credit and expensing of capital equipment.

Third, reform would end up reducing taxes on industries that face virtually no international competition (e.g. electric utilities) and raising them on industries that are fighting every day for global market share (e.g. many technology-based industries). The end result would be further movement of U.S. jobs offshore. But again, if you believe that we are not in competition who cares. Indeed, some in power today appear to hold the view that since many U.S. firms in traded industries have moved some jobs offshore that we should instead lower taxes on “Main Street” barber shops and restaurants: after all these kinds of industries have remained loyal to the United States and created jobs. Amazing! They remained “loyal” because they had no choice.

Supercuts and McDonalds aren’t going to move their barber shops and hamburger restaurants to India to take advantage of low-wage workers to serve American customers. But “traded” industries will because under with the current U.S. business and innovation climate they often have no choice.

The sooner Washington starts thinking like a state the better off we will be. States don’t blame companies that move out of state. They work to make their business climate more attractive. States don’t think they are entitled to jobs. They fight for jobs. States don’t want their tax code to be neutral. They want it to directly support their economic development goals.

Lets take another look at Nokia and Apple -- The Economist explains why the center of gravity for mobile phones moved west:

The first generations of modern mobile phones were purely devices for conversation and text messages. The money lay in designing desirable handsets, manufacturing them cheaply and distributing them widely. This played to European strengths. The necessary skills overlapped most of all in Finland, which explains why Nokia, a company that grew up producing rubber boots and paper, could become the world leader in handsets.

As microprocessors become more powerful, mobile phones are changing into hand-held computers. As a result, most of their value is now in software and data services. This is where America, in particular Silicon Valley, is hard to beat. Companies like Apple and Google know how to build overarching technology platforms. And the Valley boasts an unparalleled ecosystem of entrepreneurs, venture capitalists and software developers who regularly spawn innovative services.

Part of the announcement that Nokia has switched its primary smartphone platform to Windows Phone is that the Symbian mobile operating system is being slowly phased out. As a result, Nokia CEO Stephen Elop confirmed the company will be cutting jobs. In Finland, the numbers may be quite significant. "You're talking about 20,000 people, it's a big number," Mauri Pekkarinen, Minister for Economic Affairs, said in a statement. "We're talking about far and away the biggest process of structural change that Finland has ever seen in the new technology sector."

The lesson to take from Nokia's experience is not at all unique -- So long as companies compete for the rewards of innovation, countries will have a stake in that competition, with the result being relative winners and losers. Nations put forward many policies that influence the short and long term outcomes of innovation and thus can work in the direction of their citizens interests or against it, with the implementation of successful innovation policies no easy feat. But make no mistake -- nations are in competition, despite what economists might say.